Ravi’s Hardware Stores

• Evaluating performance

• Return on invested capital

• Net operating profits after tax (NOPAT) divided by capital invested

• Opportunity cost of capital

• ROIC = 18%. RROR = 10%

Economic Profit

• One store earned only 14%• Maximise average ROIC vs increase

economic profit• Economic profit equals ROIC less COC

multiplied by invested capital

Comparison with Rita

• Sister Rita growing aggressively – Increase in sales and operating profit

• Comparison with economic profit – Higher growth based on higher investment

• Low ROIC and declining economic profit

Discounted Cashflow

• Investment in new hardware store

• Initial decline followed by greater economic profits later

• DCF value equals initial investment plus PV of future economic profit

Fundamental Principles of Value Creation• Value is created by earning a return on invested capital

greater than opportunity cost of capital• Cost of capital depends on the risk involved in a specific

investment• The more you can invest at returns above cost of capital, the

more value you create• Growth on the basis of large investments where returns are

lower than cost of capital destroys value• Objective should be to maximise the present value of

expected cashflows or economic profit